LatAm Macro Monthly Scenario Review

August 2013

Page Global Economy

Still a Growth Recovery

3

The U.S.’s growth recovery looks less strong at the moment. This is unlikely to preclude the Fed from starting to taper QE in September, but it indicates a cautious approach. China and emerging economies in general continue to decelerate.

Brazil

Lower Growth and Less Room to Maneuver

6

Lower confidence levels point to lower economic growth. Room for countercyclical policies is limited. We expect a more depreciated exchange rate this year and in 2014.

Mexico

Currently Slowing, But Rebound in Sight

11

We have revised our growth forecast for 2013, as the economy remains weak. We expect a rebound during the second half of this year due to stronger growth in the United States. In 2014, economic reforms will likely help to boost growth.

Chile

Slower Growth

14

The economy posted a below-expectation growth during the first half of the year and inflation remains below the target.

Peru

Slowdown Ahead

17

Falling business confidence points to lower investment growth ahead. The Central Bank has been easing monetary conditions through macroprudential measures.

Colombia

Slow Growth and No Rate Hikes in Sight

18

Recent data suggest that the economy is not rebounding in the second half of this year. Amid below-potential growth and below-center-target inflation, it is unlikely that the Central Bank will deliver a tightening cycle next year.

Argentina

Thawing Out

20

As the price-freeze agreement loses effectiveness, inflation is rising. Domestic interest rates are rising and the central bank has accelerated the depreciation of the peso. International reserves have stopped declining.

Commodities

Favorable Weather Reduces Grain Prices We have made downward revisions to our 2013 year-end forecasts for corn, soybeans and wheat due to favorable weather in the United States. Improvements in refining and distribution capacity of crude oil in the U.S. are consistent with a smaller WTI discount to Brent.

Macro Research – Itaú Ilan Goldfajn – Chief Economist Tel: +5511 3708-2696 – E-mail: [email protected] Click here to visit our digital research library.

Please refer to the last page of this report for important disclosures, analyst and additional information. Itaú Unibanco or its subsidiaries may do or seek to do business with companies covered in this research report. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the single factor in making their investment decision.

23

LatAm Macro Monthly – August 2013

Slowdown in emerging economies, recovery in the U.S. Economic activity in the developed world has been improving. The U.S. recovery continues, despite lower-than-expected GDP growth in the first half of the year. The euro zone is stabilizing after a long recession. In contrast, China and emerging economies continue to cool. Growth in the U.S. is still modest this year. This should not prevent the Fed from starting to reduce the pace of quantitative stimuli in September, but suggests that it will do it cautiously. Therefore, new leaps in long-term Treasury yields seem unlikely. In this scenario, the specific fundamentals of each emerging country should now play a greater role in determining their asset prices. In Latin America, slowdown in economic activity along with low inflation figures makes room for a more-expansionary monetary policy bias. We withdrew our forecast of interest-rate hikes in Colombia. In Peru, the central bank has been loosening monetary conditions through macroprudential measures. These actions improve the prospect of growth rebounding ahead. In Mexico, we don’t expect rates to go down, but the North American recovery and the advance of structural reforms tend to benefit the economy from the second half of this year onward. There is less room for countercyclical policies in Brazil. The more-depreciated exchange rate and expectations anchored at high levels pose risks to inflation. Thus, despite the deterioration in business and consumer confidence, the central bank will probably continue to hike the interest rate and fiscal policy tends to be less stimulative at the margin. We lowered our GDP growth forecasts for 2013 and 2014. In Argentina, inflation picked up again with the end of price-freeze agreements, revealing the brief effect of that measure. The central bank has been allowing a faster depreciation of the official exchange rate and reserves stopped falling. Even with improved growth in the first half, we maintain our growth forecasts unchanged. Hope you enjoy, Ilan Goldfajn and Macro Team Scenario Review

GDP - %

World 2013 Current Previous 2.8 2.8

2014 Current Previous 3.3 3.4

GDP - % BRL / USD eop Monetary Policy Rate - eop - % IPCA - %

Brazil 2013 Current Previous 2.1 2.3 2.30 2.18 9.75 9.75 5.9 6.1

2014 Current Previous 1.7 2.2 2.40 2.18 9.75 9.75 5.8 5.9

Argentina 2013 Current Previous 2.0 2.0 6.0 5.9 21.0 21.0 28.0 30.0

2014 Current Previous 0.0 0.0 7.8 7.7 25.0 25.0 35.0 35.0

Colombia 2013 Current Previous GDP - % 3.5 3.8 COP / USD eop 1900 1900 Monetary Policy Rate - eop - % 3.25 3.25 CPI - % 2.8 2.8

2014 Current Previous 4.2 4.7 1850 1850 3.25 4.00 2.9 3.0

GDP - % ARS / USD eop BADLAR - eop - % CPI - % (Private Estimates)

Page 2

GDP - %

Latin America and Caribbean 2013 Current Previous 2.6 2.8

2014 Current Previous 2.7 3.2

GDP - % MXN / USD eop Monetary Policy Rate - eop - % CPI - %

Mexico 2013 Current Previous 2.3 2.5 12.2 12.2 4.00 4.00 3.6 3.6

2014 Current Previous 3.6 3.6 12.0 12.0 4.00 4.00 3.5 3.5

GDP - % CLP / USD eop Monetary Policy Rate - eop - % CPI - %

Chile 2013 Current Previous 4.2 4.5 510 510 4.50 4.50 2.2 2.2

2014 Current Previous 4.4 4.7 525 525 4.00 4.25 2.6 2.8

GDP - % PEN / USD eop Monetary Policy Rate - eop - % CPI - %

Peru 2013 Current Previous 5.4 6.0 2.70 2.70 4.25 4.25 2.7 2.7

2014 Current Previous 5.2 5.8 2.70 2.70 4.25 4.25 2.5 2.5

LatAm Macro Monthly – August 2013

Global economy

Still a Growth Recovery • The U.S.’s growth recovery looks less strong at the moment. This is unlikely to preclude the Fed from starting to taper QE in September, but it indicates a cautious approach. •

The euro zone’s economy is stabilizing after a prolonged recession.

•

China and emerging economies in general continue to decelerate.

• Asset prices in emerging markets will remain sensitive to movements in interest rates in the U.S., but risks of another generalized sell-off are lower and domestic fundamentals should play an increasing role. Advanced economies are recovering, but we have reduced our U.S. growth forecast. The U.S. growth story looks slightly more fragile at the moment. GDP expanded at a seasonally adjusted annualized rate of 1.7% qoq in 2Q13, above our expectation of 1.0%. However, GDP growth was revised down to an average of 1.3% (from 1.6%) in the four quarters up to 1Q13. We lowered our growth forecasts to 1.5% from 1.9% in 2013 but are maintaining 2.5% in 2014. In our view, weaker growth is unlikely to prevent the Fed from starting to taper QE in September, but it tilts the balance of risks to more monetary accommodation. Indeed, Bernanke has been showing a cautious tone. And there are reasons to be cautious with the labor market and the negative impact of the contractionary fiscal policy in U.S. This time around, it’s Europe that brings positive surprises. The euro-area economies, including the periphery, are stabilizing. The region might return to growth as early as 2Q13. We increased our GDP forecast to -0.5% from -0.7% in 2013 and to 0.9% from 0.7% in 2014. With better news coming from Europe rather than the U.S., we revised our forecast for the euro against the dollar to 1.30 at the end of 2013 (previously 1.25). Meanwhile, the economic slowdown in emerging economies continues. China’s economy keeps moderating its pace. As a consequence, policy makers adjusted their communication to show support for short-term growth. This reinforces our view that China is decelerating but will not experience a hard landing. However, risks remain on the downside. For now, we maintain our GDP forecasts at 7.5% in 2013 and 7.2% in 2014. Finally, asset prices in emerging markets will remain sensitive to movements in interest rates in the U.S., but risks of another generalized sell-off are lower. We don’t expect the yields on the 10-year U.S. Treasury to return to the low levels seen at the beginning of the year. However, another surprise spike – like the rise from about 1.60% to 2.75% in May/June – is unlikely, as the U.S. growth story appears less strong. Emerging markets’ fundamentals should play an increasing role in their asset-price movements ahead.

Will Bernanke backtrack from QE tapering given a weaker growth picture? The outlook for the U.S.’s economy remains positive, but growth momentum is weaker than previously thought. GDP expanded at a seasonally adjusted annualized rate of 1.7% qoq in 2Q13, above our expectation of 1.0%. However, GDP growth was revised down to an average of 1.3% (from 1.6%) in the four quarters up to 1Q13. We lowered our growth forecast to 1.5% from 1.9% in 2013. For 2014, we continue to expect acceleration to 2.5%, as the fiscal drag fades and financial conditions – despite the recent spike in Treasury yields – remain supportive to growth.

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LatAm Macro Monthly – August 2013

In our view, weaker growth is not likely to prevent the start of QE tapering in September, but it tilts the balance of risks to more monetary accommodation. Indeed there are reasons to be cautious with the labor market and the negative impact of fiscal policy in the U.S. The economy has added a net average of 190 thousand jobs per month in the last 12 months. However, the historical correlation suggests that, with GDP growing at 1.4% yoy over the last four quarters, payroll gains should be south of 100 thousand (see graph). Hence, payroll could decelerate, in a lagged reaction to weaker growth. Moreover, the effects of the contractionary fiscal policy have not yet completely filtered through the economy and could have longer and more intense impacts.

Payrolls have been above the level suggested by GDP growth US GDP growth (lagged by a quarter) and nonfarm payrolls 800 700

Payroll (in thousands per month)

600 500 400 300 200 100 0 -100

y = 8240.5x - 60.977 R² = 0.7635

-200 -300 -400 -500 -600

GDP growth (in % y/y)

-700 -5%

-2%

1%

4%

7%

Source: BLS, BEA, Itaú

Bernanke has shown a cautious tone. He has been pledging a change in the monetary-policy mix but no tightening in financial conditions. In its last meeting, the FOMC downgraded growth in 1H13 to modest from moderate. The statement also emphasized that financial conditions should remain accommodative for some time. In sum, although we haven’t changed our base case, we see an increasing risk of looser monetary policy in the short run. The FOMC could choose to wait for more evidence that downside risks have actually faded before starting to taper QE. Alternatively, it could go ahead with tapering in September, but concomitantly soften the forward guidance on interest rates to offset any unintended monetary tightening.

The euro area’s economy is stabilizing The euro-zone manufacturing purchasing managers’ index (PMI) reached 50.4 in July, crossing the 50 contraction/expansion threshold for the first time since July 2011. The improvement signals a stabilization in industrial production in the region after almost two years of weakness (see graph). Importantly, the gains are broad based. The manufacturing PMIs are close to 50 in the four major economies (Germany = 50.7, France = 49.7, Italy = 50.4, Spain = 49.8) in the euro area. PMIs point to stabilization in industrial production 60

Eurozone industrial production and manufacturing PMI index

yoy

10%

55

5%

50

0%

45

-5%

40

-10% Manufacturing PMI Industrial production (rhs)

35 30 2008

-15% -20%

2009

2010

2011

2012

Source: Markit, Eurostat, Itaú

2013

Several other indicators also point to an economic stabilization, suggesting that the gain is indeed based on better fundamentals. In line with our scenario, exports continue to be an important source of growth in manufacturing. Moreover, although still contracting, domestic demand is starting to stabilize as confidence and financial conditions improve with smaller tail risks and the fiscal drag begins to diminish. We increased our forecasts for Eurozone GDP to 0.5% from -0.7% in 2013 and to 0.9% from 0.7% in 2014.

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LatAm Macro Monthly – August 2013

China – Focus on growth stabilization The Chinese economy continues to moderate. The 2Q13 GDP was 7.5% higher than a year ago, a slower pace than the 7.7% seen in the first quarter. Policymakers have adjusted their policy communication, emphasizing growth stabilization. In early July, Premier Li Keqiang stated that the government should keep the economy’s performance within a reasonable range and try to avoid the growth rate from slipping below 7% year over year. He also highlighted the need to achieve this year’s official target of 7.5%. At the end of the month, the State Council announced some small, growth-supportive measures (including elimination of taxes on small businesses and expanding projects for railway construction and urban infrastructure). These measures will likely have limited direct impact on boosting aggregate demand in the short term, but are an important indication, which is in line with our view that growth will gradually decelerate but not collapse. We don’t foresee a hard landing, although risks remain on the downside. We believe that growth over the coming years will gradually slow relative to the past decade as the government attempts to rebalance the economy away from investment- and export-led growth to growth driven by consumption. Despite the government’s efforts to mitigate these problems, the fall in growth could worsen imbalances such as local governments’ indebtedness, real state over-investment, and the risk of a banking crisis due to high leverage and rising non-performing loans. For now we maintain our GDP forecasts at 7.5% in 2013 and 7.2% in 2014.

Commodities – Favorable climate reduces grain prices Agricultural prices explain most of the 0.6% drop in the average value of the Itaú Commodity Index (ICI, new methodology) in July. The breakdown by component shows that the agricultural sub-index slumped 10.4%, which was almost completely offset by rebounds in base metals (5.2%) and energy (4.1%). The ICI agricultural sub-index fell 10.4% in July and we expect lower year-end prices. Rollover of active contracts and favorable weather conditions, which reinforce the prospects of a strong crop, explained the slump in corn and soybean prices in July. We lowered our forecasts for corn, soybeans and wheat at the end of the year and now expect the ICI agricultural sub-index to fall 15.6% yoy in 2013 (previously: -10.9%). We see further downside risks to our forecasts if the USDA doesn’t revise down its estimates for harvested area in corn and soybeans by as much as we expect. Despite the recovery in July, fundamentals remain weak for metals. The ICI metals sub-index rose 5.2% in July, partially offsetting the fall in the two previous months. Prices were helped by signals from the Chinese government that it will defend the 7.5% growth target for 2013. The stimuli could include investments in railroads (positive for iron ore prices) and smart grids (positive for copper). In our view, the indication doesn’t avert the prospect of gradual deceleration in China and overall weak fundamentals for metals. We maintain our (below-consensus) forecasts for the ICI metals sub-index: -9.7% yoy in 2013, and -7.0% yoy in 2014. The ICI energy sub-index rose 4.1% in July as supply-increases in ex-OPEC are offset by lower production in OPEC countries, the WTI discount to Brent falls and refineries pass higher prices on to final products. The sub-index in is now around the same high level observed in the first quarter. We believe that these high prices, particularly in crude oil, should persist, as they are consistent with fundamentals. We note that the adjustments in the U.S. market that are leading to the WTI discount to Brent seem permanent, and we now expect a lower discount by year-end (around USD 5/bbl). With this revision, the ICI energy sub-index is now expected to rise 6.6% yoy in 2013 (previously: 5.7%).

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LatAm Macro Monthly – August 2013

Forecasts: World Economy GDP Growth World GDP growth - % USA - % Euro Area - % Japan - % China - % Interest rates and currencies Fed Funds - % USD/EUR - eop YEN/USD - eop DXY Index* - eop

2008

2009

2010

2011

2012

2013P

2014P

2.8 -0.3 0.3 -1.0 9.6

-0.6 -2.8 -4.4 -5.5 9.2

5.2 2.5 2.0 4.7 10.4

4.0 1.8 1.5 -0.6 9.3

3.2 2.8 -0.5 1.9 7.8

2.8 1.5 -0.5 1.9 7.5

3.3 2.5 0.9 1.4 7.2

0.2 1.40 90.3 83.1

0.1 1.43 92.1 76.8

0.2 1.34 81.5 80.0

0.1 1.30 77.6 79.6

0.2 1.32 86.3 79.8

0.2 1.30 105.0 86.2

0.2 1.30 105.0 88.8

Source: Central Banks, IMF, Haver and Itaú. * The DXY is a leading benchmark for the international value of the U.S. dollar, measuring its performance against a basket of currencies that includes the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona.

Brazil

Lower Growth and Less Room to Maneuver • Lower confidence levels among businesses and consumers point to lower economic growth. Economic constraints weigh on performance at the moment. Room for countercyclical policies is limited. We lowered our estimate for GDP growth in 2013 to 2.1% from 2.3%. For 2014, we cut our forecast to 1.7% from 2.2% due to the carry-over of slower growth in 2H13 and to the outlook for higher unemployment. • We changed our forecasts for the exchange rate to 2.30 reais per U.S. dollar by year-end and 2.40 by the end of 2014 from 2.18 in both cases. We reduced our estimate for the trade balance this year to zero from USD 6 billion. • Lower current inflation led us to cut our forecast for the consumer price index (IPCA) this year to 5.9% from 6.1%. For 2014, we see more uncertainty surrounding the inflation scenario. Due to lower economic growth and lower commodity prices, we reduced our inflation forecast to 5.8% from 5.9%. • We maintain our expectation that the Selic benchmark interest rate will reach 9.75% by year-end. Our forecasts for the primary budget surplus remain at 1.7% of GDP this year and at 1.1% of GDP next year.

Confidence declines and affects growth outlook GDP expansion in 2013 should be lower, despite the expectation of faster growth in 2Q13. We increased our estimate for GDP growth in 2Q13 to Confidence Declines 140 155 1.0% from 0.8%. Industrial production ended the index sa quarter up by 1.1% qoq/sa. According to our 130 145 calculations, agricultural and livestock activity 120 135 advanced more than 2% in the period. Despite the better picture for the economy in 2Q13, we lowered 110 125 our estimate for GDP growth in 2013 to 2.1% from 100 115 2.3%. We expect a flat GDP in 3Q13 and a modest pickup in 4Q13. 90

80

105

Services sector (rhs) Consumer Industry

70 Mar-04

Jul-06

Nov-08 Source: FGV

95

Mar-11

85 Jul-13

Lower confidence among businesses and consumers and deterioration in financial conditions point to economic weakness in 2H13. Consumer confidence sank 4.1% mom/sa in July, after a series of weak readings (12 drops in 14

Page 6

LatAm Macro Monthly – August 2013

months). Confidence among industrial entrepreneurs fell 4.0%, while confidence in the service sector declined 6.4%. Volatility in asset prices, street demonstrations, persistently high inflation and uncertainties surrounding fiscal policy contributed to hurt confidence. Additionally, losses in the stock market point to a worse outlook for earnings. Hence, investment is becoming less attractive, while funding sources are becoming more restrictive. Risk premium increased while long-term yields climbed. In this environment, we expect a decline in capital expenditures throughout 2H13. Consumer spending, particularly on durable goods, should also slow down. Signs of Rising Unemployment Ahead 11

%, sa

%, difficult current labor market

95

10 85 9 75 8

65

7

6

55 Unemployment rate Consumer confidence (rhs)

Carry-over and labor market conditions cause a further reduction in growth forecasts for 2014. The expectation of lower growth in 3Q13 (to zero from 0.5%) reduced by 0.3 p.p. the estimated statistical carry-over from this year’s GDP to 2014. Additionally, we expect the unemployment rate to increase due to lower growth in 2H13. As a result, the real wage bill and consumer spending should slow down. We cut our forecast for economic growth in 2014 to 1.7% from 2.2%.

45

In the credit market, new non-earmarked loans retreated in June, but earmarked loans continued 5 35 2005 2006 2007 2008 2009 2010 2011 2012 2013 to expand. Adjusting for the number of working days Source: IBGE, FGV and seasonality, new non-earmarked loans dropped 5.5% during the month, in real terms. The downward trend in the growth of the stock of nonearmarked credit continues for both the consumer and corporate segments. Private banks have been losing market share, and state-owned institutions now account for more than half of all outstanding loans, in a situation last seen in 2000. Overall delinquency over 90 days past due fell 0.21 p.p. during the month, to 3.38%. For households, delinquency dropped for non-earmarked and earmarked loans as well. For companies, the drop was only observed among non-earmarked loans. Uncertainties surrounding the macro scenario and the sluggish economic recovery may hinder the rebound in new loans and prevent substantial declines in delinquency. Economic constraints limit policy reaction to the slowdown. High and persistent inflation levels limit room for changes in monetary policy toward avoiding lower economic growth. Inflation has been close to the upper limit of the target range and inflation expectations have moved in the same direction. In this environment, even with a weaker economy, room for countercyclical monetary policy is restrained. The same goes for fiscal policy. The recurrent primary budget balance has been low. As the economy weakens, tax revenues will be lower. Hence, deterioration in the fiscal result limits the use of public spending as a channel to cushion the economic slowdown. An action in this direction could further hurt confidence and pressure risk premium, causing negative effects on economic activity in the short and, especially, in the long run.

Weaker currency Short-term factors put pressure on the Brazilian real, but long-term variables also point to a weaker currency. The exchange rate depreciated again last month, outpacing 2.30 reais per dollar. The currency reacted mostly to higher yields in U.S. bonds. We re-assessed our assumptions for terms of trade, incorporating the drop in iron-ore prices and higher crude oil prices, among other factors, which negatively impact this indicator. Furthermore, the outlook for lower availability of external savings over the long term reinforces a scenario of a weaker exchange rate. We now forecast the exchange rate at 2.30 reais per dollar by year-end and 2.40 by the end of 2014, from 2.18 previously in both cases.

Page 7

LatAm Macro Monthly – August 2013

Recent Decline in Terms of Trade 135

index, sa

130 125 120 115

Terms of trade

110 105

100 95 Jan-08 Dec-08 Nov-09 Oct-10 Sep-11 Aug-12 Jul-13 Source: Funcex, Itaú

Oil Deficit Widening 2 0 -2 -4 -6

-8 -10 -12 -14 Oil trade balance, accumulated bn dollars

2009

2010

2011

2012

More favorable figures in the balance of payments in June. With a higher trade balance and a lower service-account deficit, the current-account deficit stood at USD 4 billion in June. The seasonally adjusted annualized three-month moving average for the deficit fell to USD 76 billion as of the end of June, from more than USD 90 billion in March. On the funding side, there was another positive surprise, as USD 7.2 billion entered the country as direct investments and the same amount was invested in the local fixed-income market, in response to the withdrawal of the IOF tax. However, the deficit should widen again in July due to a negative surprise with the trade balance. The trade deficit reached USD 1.9 billion in July, driven mostly by crude-oil imports, amounting to USD 3.1 billion. Fuels continue to hurt Brazil’s trade balance, and the deficit involving fuels adds up to USD 16.7 billion year-to-date. Excluding fuels, the accumulated deficit of USD 5 billion in the trade balance would turn into a surplus of USD 11.7 billion. Therefore, we revised our estimate for the trade balance in 2013 down to zero from USD 6 billion.

As a result, our forecast for the current account deficit increased to USD 78 billion, or 3.5% of GDP -18 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec (from 3.3%). In spite of the negative impact of terms Source: MDIC, Itaú of trade on trade balance, a weaker currency and slower economic activity should act positively on the current account balance next year. We forecast the gap at 2.9% of GDP in 2014. -16

2013

Lower current inflation, but relevant risks in the future Inflation decelerated in recent months, with lower-than-expected readings. After climbing 0.26% in June (6.7% yoy), the IPCA was flat in July, and the yoy rate declined to 6.3%, due to deflation in fresh fruits and vegetables (which have been reversing part of the sharp increases seen early this year) and public-transportation fares, as governments rolled back increases in bus and train fares in several state capitals. The decline of fresh fruits and vegetables prices may be extended until September, but the effect of cuts in public-transportation fares was one-off and ended in July. We anticipate a gradual pickup of inflation to 0.3% in August and 0.5% in September, then to a monthly average of 0.6% in 4Q13. Higher inflation in the final quarter of the year will be driven by seasonal factors and by the impact of a weaker exchange rate. We reduced our forecast for the IPCA this year to 5.9% from 6.1%. Favorable surprises with inflation at the margin (particularly a sharper deceleration in the food group) were behind this revision. This move is explained by a steeper price decline in fresh fruits and vegetables and more favorable behavior of grain prices (especially corn and soybeans). The revision in our forecast for regulated prices also contributed to a downward revision of inflation this year. The inflation scenario for the next year is surrounded by uncertainties. On one hand, a stillheated labor market, increasing inflation expectations and high inflation may lead to greater passthrough of the currency devaluation than our models contemplate. The biggest risk is a pickup in inflation at the end of the year consolidating expectations at a higher level, or making the process of

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LatAm Macro Monthly – August 2013

forming expectations more reliant on past inflation and less dependent on agents’ assessments about future economic conditions and the inflation target. On the other hand, lower growth and a cooling labor market may reduce service inflation. For 2014, we have reduced our IPCA forecast slightly to 5.8% from 5.9%. Although there is a lot of uncertainty surrounding the effects of several variables on inflation next year, a slower economy and lower commodity prices should cause a slight retreat of inflation in 2014, even in a scenario of weaker currency. Still, greater inflationary inertia, inflation expectations above the target and greater risk of exchange rate pass-through are factors curbing the decline of inflation amid slower economic growth.

Hundreds

Food Prices Goes Up Again 4% MoM

3% 2% 1% 0% Average - IBGE Average - FGV End of period - FGV

-1%

-2% Jul-11

We expect less pressure on producer prices. A more-benign scenario for commodity prices also led Source: IBGE, FGV us to lower our forecast for the general price index IGP-M to 4.6% from 5.0% in 2013 and to 5.5% from 6.0% in 2014. Nov-11 Mar-12

Jul-12

Nov-12 Mar-13

Jul-13

Inflation risks persist and the Copom should continue to hike rates Despite short-term relief in inflation and expectations of slower growth, we believe that inflationary risks persist. The effects of exchange-rate depreciation on prices are yet to show up, the unemployment rate remains low and inflation expectations are consolidating above the mid-point of the target. Thus, room for countercyclical maneuvering in monetary policy is compromised. In the latest minutes and in other public communications, members of the monetary policy committee (Copom) re-affirmed their concerns with inflationary risks. The main reason for worry is currency depreciation and its impact on future inflation. Additional weakening in the Brazilian real in the past few days reinforces this concern. Therefore, we believe the Copom will choose to continue its tightening cycle, sustaining the same tightening pace in order to reduce risks for inflation in 2014. We maintain our forecast of two more 50-bp hikes in the next meetings and a final 25-bp increase in November, driving the Selic to 9.75% p.a.

Limited room for additional fiscal stimuli Extraordinary revenues contributed to a positive surprise with the primary budget balance in June. Boosted by a strong performance of regional governments, the consolidated primary budget surplus reached 5.4 billion reais (consensus: 3 billion) in June, or 1.3% of monthly GDP. Federal expenses (particularly administrative expenses) accelerated. However, thanks to non-tax revenues accrued by the central government (e.g., dividends, concessions and revenues received by public entities) and extraordinary intakes by regional governments (especially revenues received by São Paulo state in an amnesty program for renegotiation of tax debts), the result came out better than expected. Despite a positive surprise, the primary budget balance in June stood below the average for the month in 2009-2012 (1.6% of GDP). The consolidated result over 12 months was stable, at 2.0% of GDP, with the recurring annual balance (adjusting for some atypical revenues) remaining at 1.5%. In both cases, the result is lower than the target of 2.3% of GDP set for 2013. The government announced a revision in the budget, but revenues and contributions from regional governments forecasted in the budget still seem too high. On July 22, the federal

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LatAm Macro Monthly – August 2013

government published its third bi-monthly budget revision for the year, blocking 10 billion reais in expenses planned in the budget law. This new package of spending cuts by the central government, following 28 billion reais retained in the budget review done in May, signals greater concerns by authorities regarding the impact of the recent fiscal expansion on inflation. However, despite the adjustment, the 2013 budget still relies on a high level of planned expenses (based on optimistic estimates for non-tax revenues). Furthermore, the estimated contribution from regional entities for this year’s surplus also assumes a very tough adjustment on state and municipal budgets. We foresee a still-slow recovery of tax revenues this year. This expectation is valid for both the federal and regional governments. Tax breaks that are already in place (or approved) and a sluggish rebound in economic activity outline a scenario of low growth in revenues. A mighty effort to limit spending is needed (through new budget cuts or future restraints), in addition to a significant increase in other revenues, in order to achieve the primary balance target of 2.3% of GDP in 2013, as the government desires. We expect the economic cycle to be even less favorable to fiscal policy in coming quarters. Given our downward revision for economic growth in 2013 and 2014, we reduced our estimate for tax revenues by 4 billion reais (0.1% of GDP) in 2013 and by 11 billion reais (0.2% of GDP) in 2014. Public investment should expand more slowly to compensate lower tax revenues. Given that there is less room for sharper fiscal expansion (i.e., reduction in the reported primary budget surplus), as well as economic, political and operational difficulties to implement a hefty adjustment in accounts such as administrative spending and transfers in the short term, we forecast a lower volume of federal investment in 2013 and 2014. This implies less growth in central-government expenses than contemplated in our previous scenario. We now expect average spending to increase about 4% in real terms in 2013 and 2014 (previously: 5%). We maintain our estimates for the consolidated primary budget surplus at 1.7% of GDP this year and at 1.1% of GDP next year.

Forecasts: Brazil Economic Activity Real GDP growth - % Nominal GDP - BRL bn Nominal GDP - USD bn Per Capita GDP - USD Unemployment Rate - year avg Inflation IPCA - % IGP–M - % Interest Rate Selic - eop - % Balance of Payments BRL / USD - Dec Trade Balance - USD bn Current Account - % GDP Foreign Direct Investment - % GDP International Reserves - USD bn Public Finances Primary Balance - % GDP Nominal Balance - % GDP Net Public Debt - % GDP

2008

2009

2010

2011

2012

2013F

2014F

5.2 3,032 1,652 8,874 7.9

-0.3 3,239 1,620 8,600 8.1

7.5 3,770 2,142 11,228 6.7

2.7 4,143 2,473 12,853 6.0

0.9 4,403 2,252 11,610 5.5

2.1 4,788 2,219 11,347 5.8

1.7 5,131 2,180 11,069 6.5

5.9 9.8

4.3 -1.7

5.9 11.3

6.5 5.1

5.8 7.8

5.9 4.6

5.8 5.5

13.75

8.75

10.75

11

7.25

9.75

9.75

2.40 25 -1.7 2.7 194

1.75 25 -1.5 1.6 239

1.69 20 -2.2 2.3 289

1.84 30 -2.1 2.7 352

2.08 19 -2.4 2.9 379

2.30 0 -3.5 2.5 400

2.40 10 -2.9 2.5 410

3.4 -2.0 38.5

2.0 -3.3 42.1

2.7 -3.3 39.1

3.1 -2.6 36.4

2.4 -2.5 35.2

1.7 -3.6 35.0

1.1 -3.9 35.9

Source: IMF, IBGE, BCB, Haver and Itaú.

(For our monthly Brazil forecasts, click here.)

Page 10

LatAm Macro Monthly – August 2013

Mexico

Currently Slowing, But Rebound in Sight • Mexico’s PAN (the largest opposition party) has presented an aggressive energy reform bill. The PRI (the ruling party) will send its proposal for the reform soon. Both proposals seek to change the constitution. • We have revised our growth forecast for 2013 to 2.3%, as the economy remains weak. We expect a rebound during the second half of this year due to stronger growth in the United States. • Reforms and lower volatility in financial markets will likely lead to exchange-rate appreciation. Our year-end forecasts for the peso stand at 12.2 to the dollar for 2013 and 12.0 to the dollar for 2014. • Inflation fell sharply in the first half of July, while core inflation reached a new record low. Inflation will likely end this year at 3.6%. • Although the central bank is concerned with the weak activity numbers and comfortable with the inflation readings, we do not expect rate cuts in our forecast horizon.

The debate on energy reform starts The PAN (Mexico’s largest opposition party) has presented an aggressive energy reform bill. Although divisions within the PAN remain deep, even after the party won the governmental elections in Baja California (on July 7), it seems that the party members are on the same page when it comes to energy reform. The bill, if approved, would change Mexico’s constitution to allow domestic and foreign private investment in every area of the energy industry (exploration, refining, transportation, etc.) through a concession scheme, although foreign participation in oil blocks would be capped at 75%. The bill would also open the way for the listing of a “small amount of PEMEX shares”. Union leaders would be removed from PEMEX board, which would likely make PEMEX a company more attractive to investment. Mexico’s PRI (the ruling party) is expected to submit an alternative energy bill within the next few days. While there aren’t many details available on the PRI proposal at this point, it is already known that it will also seek to change the constitution. So the alternative proposal will probably be seen as positive by the markets too. In our view, the PAN and the PRI will likely find enough common ground to pass a meaningful reform. The PAN and the PRI together have enough seats in Congress to change the constitution. So even though the left-wing PRD is opposing constitutional changes, a far-reaching energy reform stands a good chance of passage. Still, the risks facing the energy reform effort cannot be dismissed. The PAN is demanding changes in the political system before it votes on the energy reform. At the same time, Lopez Obrador, who recently left the PRD, is calling for a protest campaign against the energy reform beginning on September 8. History has shown that Obrador’s ability to bring supporters out into the streets should not be underestimated. A tax reform bill is also expected to be submitted to Congress soon. As with every single reform sent to Congress over the past few months, details will not be released until shortly before the bill is submitted. Still, the imposition of a VAT on food and medicines is one likely outcome and remains part of our base-case scenario.

Page 11

LatAm Macro Monthly – August 2013

Expecting a better second half The IGAE (monthly proxy for GDP) for May hints that growth during 2Q13 was even lower than in 12% QoQ/SAAR the first quarter of the year. The index gained 10% 0.45% from April, following a 0.7% decrease, bringing quarter-over-quarter growth close to zero. The 8% IGAE number’s breakdown reveals that the Service sector 6% grew by 0.34% from April (vs. -0.54% the previous 4% month), while the Industrial sector grew by 1.4% month over month (following a 1.8% drop the month 2% before). Finally, the small and volatile Agricultural 0% sector fell 0.26% (vs. +8.6% in April). The demandside indicators available so far hint at weak -2% consumption and investment during 2Q13. Imports of May-10 May-11 May-12 May-13 Source: INEGI, Itaú capital goods contracted during the second quarter. Although retail sales increased by 0.8% from April, the result comes after a 0.8% month-over-month drop, highlighting that the trend remains weak at the margin. On the other hand, the trade balance figures hint that external demand is gradually picking up: manufacturing exports were up 12% qoq/saar during the 2Q13 (vs. -5.3% for the previous quarter). Primary fiscal expenditures also picked up after a sharp contraction in the previous quarter, suggesting stronger public sector demand. The Weakness Continues

We now expect Mexico’s economy to grow by 2.3% this year. Previously, we were expecting 2.5% growth. In our scenario, Mexico’s economy grows at a strong pace from the second half of this year on, boosted by the (expected) recovery in the United States. Our low forecast for GDP this year is mostly due to the unfavorable carry-over effects produced by the disappointing growth figures of the first half of the year. For 2014, our growth forecast is unchanged, at 3.6%. In our view, next year Mexico’s economy will benefit not only from a cyclical recovery in the U.S. but also from structural factors linked to progress made on the reform agenda.

Headline inflation falls within the target range, while core inflation reaches a new record low Mexico’s consumer price index was flat over the first half of July, far below the market consensus estimate of 0.11% inflation. Core inflation came in at 0.04%. The low headline inflation was due to lower prices for both core goods (-0.06%) and non-core food items (-0.78%). Non-core food prices are now down 5.5% from the peak reached in the first half of April. As a result of both low sequential inflation and favorable base effects, headline inflation fell substantially on a year-over-year basis, to 3.53% (from 3.93% in the second half of June), and now stands firmly within the target range. The fall was mostly due to a sharp decrease in non-core inflation (to 6.62%, from 7.83% previously), which is typically very volatile. However, core inflation also fell substantially, to 2.57% (from 2.74% previously) – below the midpoint of the target range and a new record low. The decrease in core inflation came mostly from the goods component (now at 2.75%), likely influenced by the lagging impact of exchange-rate appreciation. Meanwhile, inflation for core services remains low, at 2.41%. Our year-end inflation expectations remain at 3.6% for 2013 and 3.5% for 2014. Annual inflation will likely continue to fall before resuming an upward trend in November. Next year, the tax reform will likely lift consumer prices, as the government is expected to introduce a VAT on food and medicines. In our forecast, we are assuming that the government will introduce the VAT on these items only gradually.

Page 12

LatAm Macro Monthly – August 2013

Weaker internal demand improves the trade balance On a seasonally adjusted basis, the trade balance posted a USD 9.4 billion (annualized) deficit for 2Q13, down from USD 12.3 billion in the previous quarter. The result was led by a decline in the non-energy deficit (to USD 15.3 billion from USD 20.1 billion the previous quarter). Exports increased by 0.8% from May to June, bringing growth in 2Q13 to 4.5% qoq/saar. Imports fell by 1.2% month over month and increased by a modest 1.1% qoq/saar (vs. 8.6% in 1Q13). We expect the Mexican peso to end this year at 12.2 to the dollar. For year-end 2014, we expect an exchange rate of 12.0 pesos to the dollar. As the market becomes less volatile and positive news on the reforms come, the Mexican peso will likely resume an appreciation trend. Apart from idiosyncratic factors, the Mexican peso will likely outperform the other LatAm currencies because of the relative performance of the U.S. economy vis-à-vis China’s.

Low growth, tamed inflation, but unchanged interest rates Downside risk to both growth and inflation. As widely expected, the board of Mexico’s central bank unanimously voted to leave the policy rate unchanged, at 4.0%, in July. However, both in the press statement that accompanied the decision and in the minutes of the meeting, board members expressed a lot of concern over the recent weak activity numbers. Most board members agreed that the downside risks for Mexico’s activity have intensified, even though they recognize the positive developments in the United States. In addition, the central bank again sounded confident that inflation was high due to transitory factors (the meeting took place while headline inflation was still above the upper bound of the target range), emphasizing the low core inflation readings. Still, we do not expect rate cuts in our forecast horizon. The minutes of the meeting revealed extensive debate among the board members over the possible reduction in the Fed’s assetpurchasing pace and its potential impact on Mexico. In their concluding remarks, the board members once again made clear that monetary policy abroad, in particular in the U.S., will be an important variable in its future policy moves.

Forecasts: Mexico Economic Activity Real GDP growth - % Nominal GDP - USD bn Population (millions) Per Capita GDP - USD Unemployment Rate - year avg Inflation CPI - % Interest Rate Monetary Policy Rate - eop - % Balance of Payments MXN / USD - eop Trade Balance - USD bn Current Account - % GDP Foreign Direct Investment - % GDP International Reserves - USD bn Public Finances Nominal Balance - % GDP Net Public Debt - % GDP

2008

2009

2010

2011

2012

2013F

2014F

1.2 1,094 109.5 9,993 4.0

-6.0 883 111.3 7,935 5.5

5.3 1,034 112.9 9,166 5.4

3.9 1,159 114.3 10,142 5.2

3.9 1,177 115.6 10,184 5.0

2.3 1,304 116.8 11,165 5.0

3.6 1,456 117.9 12,347 4.8

6.5

3.6

4.4

3.8

3.6

3.6

3.5

8.25

4.50

4.50

4.50

4.50

4.00

4.00

13.54 -17.3 -1.8 2.5 85.4

13.06 -4.7 -0.8 1.9 90.8

12.36 -3.0 -0.2 2.1 113.6

13.99 -1.5 -0.9 1.9 142.5

13.01 0.0 -1.0 1.1 163.5

12.20 -5.0 -1.4 2.0 193.0

12.00 -7.0 -1.5 2.5 208.0

-0.1 18.2

-2.3 29.0

-2.8 30.6

-2.5 32.2

-2.6 33.7

-2.0 33.6

-2.0 33.3

Source: Central Bank, IMF, INEGI, Haver and Itaú.

Page 13

LatAm Macro Monthly – August 2013

Chile

Slower Growth • The economy posted a below-expectation growth during the first half of the year, while some leading indicators also declined recently. We now expect the Chilean economy to grow 4.2% this year and 4.4% in 2014. • The consumer price index rose 0.6% month over month in June, but annual inflation remains below the lower bound of the target range. Moreover, core measures show no demand-side inflationary pressure despite the tight labor market. Consistent with the revision in our growth forecast, we now expect inflation to end 2014 at 2.6%; our 2.2% forecast for 2013 remains unchanged. • The monetary policy rate was maintained at 5.0% in July, but an easing bias was introduced in the press statement following the decision. We expect the central bank to cut the interest rate by 25 bps in August and by another 25 bps before the end of 2013. We also expect the reference rate to reach 4.00% in 2014. Still, the odds that the central bank decides to postpone the beginning of the easing are not low. • Higher costs are reducing CODELCO’s profit margin. As a result, we reduced our fiscal-balance forecast to -0.8% of GDP in 2013. For 2014, we reduced our forecast to -0.3%, also taking into account the revision in our growth forecast. • Evelyn Matthei is the government coalition’s presidential candidate, following Pablo Longueira’s decision not to run. Given that the election will be held on November 17, the details of her economic proposals are likely to come out soon.

Below-trend growth A Below-Trend Economy 15% QoQ/SAAR

10%

5%

Activity remains weak. Despite a 1.0% month-overmonth gain in June’s IMACEC (monthly GDP proxy), the index rose by a modest 2.6% (annualized) during 2Q13 (vs. 2.1% the previous quarter). Year-to-date, activity posted a 4.1% increase from a year earlier. Once again the sector performances were mixed in June: retail sales gained 7.7% year over year, while manufacturing fell 2.7%.

Many leading investment indicators point to further weakness ahead, while consumer IMACEC confidence and tighter credit standards suggest -5% that consumption will also lose momentum. Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Building permits decreased 11.9% year over year in Source: Central Bank of Chile, Itaú June, while the IMACON index (a monthly proxy for construction activity) rose 4.6% (down from 11.5% in 2012) and construction material sales contracted 11.7% in May. On the other hand, capital goods imports (a proxy for machinery investment) grew a strong 18% year over year in July. 0%

We now expect the Chilean economy to grow 4.2% this year and 4.4% in 2014. In our previous scenario, our growth forecast stood at 4.5% and 4.7% for 2013 and 2014, respectively. The belowtrend growth will likely cause a rise in the unemployment rate; we now expect 6.4% in 2013 and 7.2% in 2014.

Page 14

LatAm Macro Monthly – August 2013

Our growth forecasts are below market consensus. According to the central bank’s July Economic Expectation Survey, market analysts revised their GDP forecasts, from 4.6% to 4.4% for 2013 and from 4.7% to 4.5% for 2014. We believe there is room for further reductions in GDP expectations in the coming surveys.

Confidence Is Lower Than It Used To Be 70 65

Business Consumer

60

55 50

Inflation remains low

45 40

The consumer price index increased 2.2% year over year in July, below the center of the target, while inflation excluding food and energy stood at 30 Jun-07 Jun-09 Jun-11 Jun-13 0.9% year over year. The higher inflation in July was Source: Adimark, Icare and Itaú mostly attributable to the 4.2% year over year increase in energy prices. As a result, tradable inflation reached 1.5% year over year (vs. 0.9% in June). Non-tradable inflation fell to 3.0%, matching the target’s center, underscoring the lack of demand-side inflationary pressure. 35

Lower growth is likely to offset the impact of a weaker peso. Our year-end inflation forecast for 2013 remains unchanged at 2.2%. For 2014, we see inflation at 2.6% (vs. 2.8% in our previous scenario), still below the target’s center.

Is the easing cycle about to start? The central bank’s latest monetary policy report introduced rate cuts to its baseline scenario. The central bank revised its GDP forecast for this year, to 4.0%-5.0% (from 4.5%-5.5% in the previous report), mostly due to weaker investment growth. The official inflation forecast for this year was also revised, to 2.6% (vs. 2.8% previously). According to the central bank, in this scenario the policy rate would follow a path similar to market expectations (at that point), implying interest rate cuts of 25 to 50 bps before the end of the year. Although the central bank maintained the policy rate unchanged in July, it introduced an easing bias in the press statement that accompanied the decision. According to the minutes of the meeting, board members considered lowering the reference rate by 25 bps for the third consecutive month. However, the board decided to keep the rate unchanged to avoid surprising the market (which was expecting unchanged rates), and to wait for further evidence that consumption is actually weakening. We currently expect the easing cycle to start in August, and see room for a 100-bp easing cycle. In our view, the recent numbers confirm that all demand components are weakening, while the easing bias introduced in the press statement following the July decision should avoid a surprise if the board decides to lower rates in August. In our scenario, the reference rate will end the year at 4.5%, which is consistent with the central bank’s baseline scenario. However, we see room for another 50bp cut in 2014, as the economy grows below trend and inflation runs below 3%. Our previous scenario called for a reference rate of 4.25% at the end of 2014. However, we acknowledge that the odds that the central bank decides to postpone the beginning of the easing cycle are not low. The central bank may decide to wait for more information confirming that the economy is slowing enough to justify rate cuts.

Lower public-sector revenue led to higher fiscal deficit Chile’s government ran a fiscal deficit of USD 494.3 million in the second quarter of 2013, equivalent to 0.2% of annual GDP. This number reflects the government’s higher fiscal spending (+9.5% year over year in real terms) and lower revenue (-8.5%), which was hurt by both lower copper

Page 15

LatAm Macro Monthly – August 2013

prices (copper tax revenue declined 40%) and lower economic growth. Thus, after reaching a surplus of 0.8% in the first quarter, the government has now recorded a surplus of 0.6% of GDP (USD 1.8 billion) in the first half of the year (down 65.1% from a year earlier). In our view, the government will continue to increase its fiscal spending (according to the budget), despite further reductions in revenue. Considering this scenario, and the weaker earnings from CODELCO (the state-owned copper company), we lowered our fiscal-balance forecast to -0.8% and -0.3% of GDP for 2013 and 2014, respectively (from 0.2% and 0% in our previous scenario).

A new government coalition candidate The UDI (one of the political parties of the ruling alliance) confirmed that Evelyn Matthei will be its presidential candidate. The announcement came after Pablo Longueira dropped out of the race. Longueira had won the primaries against Andres Allamand (of Renovación Nacional, the other party of the government’s coalition), but decided not to run for personal reasons. Ms. Matthei has served as Labor Minister under President Piñera and, before that, occupied key positions in both the lower house and the senate. The Renovación Nacional party (RN) supported Matthei’s candidacy, making her the sole candidate for the government coalition. The coalition’s main challenge is to provide a sense of unity to the people, especially considering the weak voter support for the governing alliance (only 26% in the latest primaries) and the previous candidates’ failures (Matthei is the third presidential candidate in only four months). Given that Bachelet comes from the center left and Matthei from the center right, we believe the presidential campaign will be marked by the battle to win more votes from the center. We must pay close attention to any potential changes in proposals that indicate significant differences between the candidates, such as education, pension funds, tax reform and energy.

Forecasts: Chile Economic Activity Real GDP growth - % Nominal GDP - USD bn Population (millions) Per Capita GDP - USD Unemployment Rate - year avg Inflation CPI - % Interest Rate Monetary Policy Rate - eop - % Balance of Payments CLP / USD - eop Trade Balance - USD bn Current Account - % GDP Foreign Direct Investment - % GDP International Reserves - USD bn Public Finances Nominal Balance - % GDP Net Public Debt - % GDP

2008

2009

2010

2011

2012

2013F

2014F

3.3 179.6 16.8 10,715 7.8

-1.0 172.3 16.9 10,180 9.6

5.8 217.6 17.1 12,727 8.3

5.9 251.2 17.2 14,563 7.2

5.6 267.5 17.4 15,375 6.5

4.2 280 17.6 15,974 6.4

4.4 287 17.7 16,201 7.2

7.1

-1.5

3.0

4.4

1.5

2.2

2.6

8.25

0.50

3.25

5.25

5.00

4.50

4.00

629 6.1 -3.2 8.6 23.2

506 15.4 2.0 7.5 25.4

468 15.6 1.5 7.1 27.9

521 10.5 -1.3 9.1 42.0

479 3.4 -3.5 11.3 41.6

510 2.1 -4.7 7.0 43.0

525 -1.0 -4.9 5.5 45.0

4.7 -22.6

-4.3 -12.0

-0.3 -7.8

1.5 -10.7

0.6 -7.8

-0.8 -7.8

-0.3 -8.6

Source: Central Bank, IMF, INE, Haver and Itaú.

Page 16

LatAm Macro Monthly – August 2013

Peru

Slowdown Ahead • Falling business confidence points to lower investment growth ahead. We reduced our GDP growth forecast to 5.4% this year and 5.2% next year. • The deceleration in investment and a recovery of mining production will probably reduce the pressure on the current-account deficit, which widened to 4.6% of GDP in the first quarter. • The Central Bank has been easing monetary conditions through macroprudential measures. Policy-rate cuts are a possibility but still not our base-case scenario.

Downward growth revisions Investment Needs Confidence 80

40%

75

30%

70 20%

65 60

10%

55 0%

50

45

Private investment (%yoy) (right) Confidence on the Economy in 3m (t-1q)

40 35 30 Dec-05

-10% -20%

-30% Dec-13

Dec-09 Source: INEI, Central Bank, Itaú

Business confidence fell 14 points from March to June, indicating less private investment growth in the second half of this year. The index measured by the Central Bank now stands at 51.0 points in June, the lowest since August 2011, when it was still recovering from the uncertainty generated by President Humala’s election. The reasons that firms have become less optimistic in recent months seem to be the decline in commodity prices and the uncertainty regarding economic policy, after Humala attempted to buy Repsol’s assets in Peru and supported the election of Maduro in Venezuela. Peru’s growth has been led by private investment, which depends on business confidence.

GDP growth probably slowed to 4.8% year over year in June, down from 5.0% in May. Preliminary activity data revealed that cement consumption growth, which correlates with the expansion of construction, declined to 5.7% year over year in June, from 12.4% in May. Meanwhile, mining (6.0%), electricity (6.7%) and fishing (2.2%) activities accelerated. The results suggest that the deceleration will indeed be focused on investment. Our forecast for GDP growth in June is 4.8%. We reduced our GDP growth forecast to 5.4% this year (from 6.0%) and to 5.2% next year (from 5.8%). The sharp decline in business confidence came as a surprise to us. We thought that conditions would improve after President Humala refused to go ahead with the Repsol deal and announced market-friendly measures, such as reducing the bureaucracy for investments. Lower copper and gold prices may keep business confidence at low levels.

Lower growth to slow the widening of the external gap The good news is that slower investment growth, coupled with a recovery of mining production, will probably reduce pressure on the current-account deficit. The current-account deficit accumulated over twelve months widened to 4.6% of GDP in the first quarter, and trade-balance data for April and May (deficit of 0.9 billion dollars) suggest an additional deterioration in the second quarter. Looking ahead, the deceleration of investment and the recovery of mining production (which reflects some mining projects starting operations) suggest that the gap between export and import growth will narrow and alleviate the current-

Narrowing Gap 50%

yoy, 3m

40% 30% 20% 10% 0% -10% -20% -30% -40% May-05

Exports Imports in volumes May-07

May-09

May-11

May-13

Source: Central Bank, Itaú

Page 17

LatAm Macro Monthly – August 2013

account deficit. Therefore, despite the negative surprises with the trade balance in the last couple of months, we maintain our forecast for the current-account deficit at 4.4% of GDP this year and 3.5% next year. We have also maintained our forecast for the FX rate at 2.70 soles per dollar for both this year and 2014. The central bank cut reserve requirements, but will probably not cut the policy rate. Peru’s central bank has maintained the policy rate unchanged at its current level (4.25%) for slightly more than two years. Amid the strong growth rates the country has enjoyed until recently, the central bank had been tightening conditions through hikes in the reserve requirement for both dollars and soles. The latest movement, however, was intended to ease monetary conditions. The Central Bank slashed reserve requirements from 30% to 25% for deposits in soles and from 55% to 50% for deposits in dollars. Given the ongoing deceleration, the monetary authority will probably continue decreasing reserve requirements. Cuts in the policy rate could come in case the economy decelerates more steeply than contemplated in our scenario.

Forecasts: Peru Economic Activity Real GDP growth - % Nominal GDP - USD bn Population (millions) Per Capita GDP - USD Unemployment Rate - year avg Inflation CPI - % Interest Rate Monetary Policy Rate - eop - % Balance of Payments PEN / USD - eop Trade Balance - USD bn Current Account - % GDP Foreign Direct Investment - % GDP International Reserves - USD bn Public Finances Nominal Central Govt Balance - % GDP Gross Central Govt. Debt - % GDP

2008

2009

2010

2011

2012

2013F

2014F

9.8 126.6 28.8 4,396 8.4

0.9 127.0 29.1 4,360 8.4

8.8 153.6 29.5 5,212 7.9

6.9 176.2 29.8 5,913 7.7

6.3 200.4 30.1 6,612 6.8

5.4 217 30.5 7,116 6.6

5.2 227 30.9 7,359 6.4

6.7

0.2

2.1

4.7

2.6

2.7

2.5

6.50

1.25

3.00

4.25

4.25

4.25

4.25

3.11 2.6 -4.2 5.4 31.2

2.88 6.0 -0.6 5.1 33.1

2.82 6.7 -2.5 5.5 44.1

2.70 9.3 -1.9 4.7 48.8

2.57 4.5 -3.6 6.1 64.0

2.70 0.7 -4.4 5.0 72

2.70 2.5 -3.5 5.0 80

2.4 24.2

-1.3 27.3

-0.2 23.5

1.9 21.2

2.1 18.4

1.5 16.5

1.2 15.7

Source: Central Bank, INEI, Haver and Itaú.

Colombia

Slow Growth and No Rate Hikes in Sight • Recent data suggest that the economy is not rebounding in the second half of this year. We reduced our forecast for GDP growth to 3.5% this year and to 4.2% next year. • Amid below-potential growth and below-center-target inflation, it is unlikely that the Central Bank will deliver a tightening cycle next year. We now forecast Colombia’s policy rate to remain at the current 3.25% until the end of 2014.

Economic growth continues to slow The IMACO leading indicator suggests that growth continues to decelerate in the beginning of 2H13. Published by the Central Bank, the IMACO correlates with GDP growth 5 months ahead. The index is composed of energy demand, industrial orders, retail sales, production of capital goods, M3, industrial productivity and interest rates. Its declining trend started in early 2012 and suggests that the economy continues to slow in the third quarter of this year.

Page 18

LatAm Macro Monthly – August 2013

Still Slowing 9%

7% 5% 3% 1% GDP 12M growth IMACO (t-5)

-1%

-3%

Investment and business confidence are also weakening again. Imports of capital goods, which correlate well with investment in machinery and equipment, declined at an annualized pace of 12.8% in the three months ended in May, after a recovery in the first quarter (+25.0% annualized). In addition, a report from Fedesarrollo, a local think-tank, revealed that business confidence in the industrial and trade sectors has been falling. The results suggest that investment will probably remain slow in the third quarter.

-5% Aug-13

Is consumption recovering? Retail sales expanded at an annualized rate of 10.4% in the three months Source: Central Bank, Itaú ended in May, recovering from a weak first quarter. These results are in contrast to all other economic activity indicators, which have been showing a weak trend. The strong acceleration in retail sales may be only a result of volatility in the data, since employment and wages are growing only moderately, while new loans to consumers continue to decline. Aug-93

Aug-97

Aug-01

Aug-05

Aug-09

We reduced our GDP growth forecast to 3.5% this year (from 3.8%) and to 4.2% (from 4.7%) next year. The available indicators led us to revise our growth forecasts downward for the second half of this year. We now expect quarterly growth in the second half to average 3.2% annualized (4.8% previously), weakening the carry-over for 2014. Why is the Colombian economy slower than in past years? In our view, some external and domestic factors stand out: A less-favorable scenario for Colombia’s main export products, oil and coal, slows down investment and production in the commodities sector. Manufacturing production has been weak because of slower domestic and external demand and the more appreciated real exchange rate when compared with past years. Finally, bank-lending growth, especially to consumers, continues to slow down. Delinquency rates for consumers continue to display a rising trend and banks are still cautious in granting new loans, according to the Central Bank’s survey of credit conditions.

Fx forecast unchanged The Colombian peso is weakening against the dollar but outperforming its Andean neighbors, Chile and Peru, mainly because of the better dynamics of its terms of trade. Colombia’s terms of trade have suffered less than Chile’s and Peru’s. Unlike metal commodities, energy commodities are mostly consumed in developed countries. Therefore, the current scenario in which the U.S. is improving while China decelerates has caused a smaller effect in energy prices, such as oil and coal, than in metal prices.

Colombian Peso Outperforms 110 05/01/2013 =100

108

106 104 102 Chile Colombia Peru

100 98 1-May-13

The Central Bank continues to buy dollars, despite the weaker peso. The monetary authority Source: Bloomberg, Itaú decelerated purchases to around USD 20 million per day when the peso approached 1950 per dollar by the end of June/early July. But when the currency appreciated to around 1870 by mid-July, dollar purchases were increased again to USD 30 million per day. In all, the peso continues to hover around the 1900 level, which is our forecast for the end of this year. For 2014, we forecast a slight appreciation to 1850. 31-May-13

30-Jun-13

30-Jul-13

Page 19

LatAm Macro Monthly – August 2013

We expect no rate hikes ahead Below-potential GDP growth and tame inflation reveals no need to raise rates, in our view. In July, inflation stood at a low 2.2% yoy. If our scenario of slower economic growth is confirmed, inflation will probably remain in check. The depreciation of the peso (7.5% since the beginning of this year) will probably add some pressure on tradable prices, but weak domestic demand is consistent with lower non-tradable inflation. We reduced our inflation forecast for 2014 to 2.9% from 3.0%. For this year, we expect 2.8%. The Central Bank is also comfortable with the inflation outlook. In its latest statement, members maintained the policy rate unchanged and lowered the GDP growth forecast for this year to 4.0%, from 4.3%. In the forward-looking paragraph, members argued that “economic-activity indicators and their forecasts show a level of output lower than what can be generated given the installed capacity.” Members continue to say that monetary and fiscal actions already taken will contribute to strengthen economic growth this year, but stopped saying that growth will reach its potential, as it argued in previous meetings. They also stated that “inflation is low” and its expectations are “anchored at center-target (3.0%).” We now expect the Central bank to maintain the policy rate at 3.25% until at least the end of 2014. Previously, we forecasted a 75-bp tightening cycle next year, to 4.0%.

Forecasts: Colombia Economic Activity Real GDP growth - % Nominal GDP - USD bn Population (millions) Per Capita GDP - USD Unemployment Rate - year avg Inflation CPI - % Interest Rate Monetary Policy Rate - eop - % Balance of Payments COP / USD - eop Trade Balance - USD bn Current Account - % GDP Foreign Direct Investment - % GDP International Reserves - USD bn Public Finances Nominal Balance - % GDP Gross Public Debt - % GDP

2008

2009

2010

2011

2012

2013F

2014F

3.5 244 44.5 5,496 11.3

1.7 234 45.0 5,199 12.0

4.0 287 45.5 6,305 11.8

6.6 336 46.1 7,304 10.8

4.0 358 46.6 7,691 10.4

3.5 386 47.1 8,183 9.0

4.2 404 47.7 8,483 8.5

7.7

2.0

3.2

3.7

2.4

2.8

2.9

9.50

3.50

3.00

4.75

4.25

3.25

3.25

2244 0.4 -2.8 4.3 24.0

2044 1.7 -2.1 3.1 25.4

1914 1.4 -3.1 2.4 28.5

1943 5.0 -2.8 4.0 32.3

1767 4.9 -3.1 4.3 37.4

1900 4.0 -3.5 3.8 42.3

1850 4.5 -3.4 4.0 47.8

-0.5 30.9

-2.2 36.1

-2.7 36.4

-2.9 34.2

-2.4 32.2

-2.2 30.9

-2.1 30.0

Source: Central Bank, DANE, Haver and Itaú.

Argentina

Thawing Out •

As the price-freeze agreement loses effectiveness, inflation is rising.

• Domestic interest rates are rising and the central bank has accelerated the depreciation of the peso. We expect now the peso to weaken by 22% this year, to 6 pesos to the dollar. • International reserves have stopped declining. External borrowing from the central bank and import controls may allow the central bank to start building up reserves again from their current level. We still expect reserves to end this year USD 4.0 billion below their year-end 2012 level.

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LatAm Macro Monthly – August 2013

Faster depreciation of the peso in the official market Slower monetary expansion due to lower foreign-exchange inflows (but not less financing to the Treasury) and higher credit demand have led to a rise in interest rates in Argentina. The Badlar rate hit 17.8% recently. We are leaving unchanged our year-end rate forecasts, at 21% for 2013 and 25% for 2014. The depreciation of the peso in the official exchange-rate market accelerated sharply in July, to 28% from 20%. At the 25% annual depreciation pace that we expect from now on, the peso would end this year 22% weaker (in nominal terms) than one year before (therefore ending 2013 at 6.0 pesos to the dollar). We are leaving unchanged our estimate of 30% depreciation for next year, which would bring the exchange rate to 7.8 pesos to the dollar by December 2014. Meanwhile official intervention in the blue-chip swap market, higher interest rates and persistent police controls on “blue” transactions are sustaining a spread of around 50% between the informal and the official FX rate. Running Faster 30

%

28

Annual rate of depreciation

25

23 22 21

20 18 16 15

15

16

21 19

18 17

15

Gross international reserves stopped declining in July. Year-to-date, reserves are down by USD 6.2 billion due to a number of factors: a low rollover of external private debt, a higher deficit in the tourism account and public external debt repayments. We expect the central bank to rely again on external loans to build up the level of international reserves. This financial facility, together with import controls, is consistent with our expectation of a USD 4.0 billion loss for the full year of 2013. In the meantime, the tax amnesty launched last month has failed to bring in dollars so far.

10 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13

However, we now expect a bigger drop in international reserves next year. We now estimate a USD 7.0 billion loss in reserves (up from our previous estimate of a USD 3.4 billion loss), in which case international reserves would reach USD 32.3 billion by December 2014. In 2014, reserves will likely be drained by a further deterioration in the tourism account (due to the World Cup in Brazil) and lower private foreign exchange inflows. The drop could even be higher if a payment of GDP unit (based on an official growth rate higher than 3.2%) is triggered. Source: BCRA, Itaú

Moving up The price-freeze agreement is no longer working. According to private-sector estimates, consumer prices rose by 1.9% month over month in June, compared with a 1.63% rise in the same month last year. Annual inflation rose to 23.8% in June from 23.4% in May, after posting four consecutive declines. The declines of the previous months are attributable to the agreement between the government and the country’s largest supermarkets and other stores to freeze prices from February through May. Universidad Di Tella announced that, according to its surveys, inflation expectations for the next 12 months remain at 30%. According to preliminary estimates, inflation may hit 3% mom in July. While it is true that seasonal factors are also contributing to higher sequential inflation, annual inflation would also rise (to 25%). From August on, we expect higher and rising inflation rates compared with 2012. Nonetheless, we have adjusted our 2013 inflation forecast to 28% from 30%. Our 2014 inflation expectation is unchanged, at 35%. A weaker exchange rate in both the official and parallel markets will likely drive up inflation next year.

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LatAm Macro Monthly – August 2013

Better-than-expected activity in the first half of 2013 The agricultural sector is boosting the economy. The IGA, a GDP proxy calculated by the consulting firm OJF, rose by 5.1% year over year (following a 6.0% gain in May). However, on a sequential basis, activity dropped by 0.9% from the previous month, offsetting the May gain. We expect the economy to decelerate in the second half of 2013, bringing growth to 2% for the full year. Tighter import controls, lower growth in Brazil and weaker harvest growth will likely lead to zero growth next year.

Nominal devaluation prevents further deterioration in fiscal accounts The federal public sector balance posted a deficit of 660 million pesos in May 2013 (vs. a surplus of 108 million pesos one year before). As a consequence, the 12-month rolling deficit continued to increase, to 58.1 billion pesos in May 2013 from 55.6 billion pesos in December 2012. During the first five months, primary expenditures grew by 30.1% yoy, while tax revenues rose by 27.9%. Profit transfers from the central bank, a product of last year’s exchange-rate depreciation, continued to play a key role in controlling the public deficit. During that period, the monetary authority remitted 6.7 billion pesos, or 70% of the year-to-date deficit. We expect the fiscal deficit to drop to 1.9% of GDP in 2013, from 2.6% in 2012, driven by larger profit transfers from the central bank.

Waiting for the justice There is high degree of consensus among lawyers regarding the outcome of the pari passu litigation. It is expected that the Court of Appeals will issue a negative ruling against Argentina before the beginning of September. But it is still unclear how the court will compel Argentina to comply with the pari passu clause. Argentina will likely request a stay of the decision and appeal to the U.S. Supreme Court, thereby avoiding a technical default, at least in the short term. Mid-term elections will take place on October 27 (with primaries next August 11). One third of the seats (24) in the Senate and half of the seats (127) in the lower chamber will be at stake. The incumbent Frente para la Victoria will have 13 seats at risk in the Senate (54%), and its allied parties may lose up to 6 seats. In the lower chamber, 38 seats held by Frente para la Victoria and 13 seats held by its allied parties will be contested. It is likely, according to current polls, that the Kirchner coalition will lose senators but retain its current number of representatives in the lower chamber. If that were the case, President Kirchner would become weaker. She is therefore unlikely to pursue a constitutional reform that would allow her to run for another term as president.

Forecasts: Argentina Economic Activity Real GDP growth (Private Estimates) - % Nominal GDP - USD bn Population (millions) Per Capita GDP - USD Unemployment Rate - year avg Inflation CPI (Private Estimates) - % Interest Rate BADLAR - eop - % Balance of Payments ARS / USD - eop Trade Balance - USD bn Current Account - % GDP Foreign Direct Investment - % GDP International Reserves - USD bn Public Finances Nominal Balance - % GDP Gross Public Debt - % GDP

2008

2009

2010

2011

2012

2013F

2014F

3.1 324.8 39.7 8,171 7.9

-4.2 305.5 40.1 7,611 8.7

8.0 368.7 40.5 9,100 7.8

5.1 446.0 40.9 10,904 7.2

-0.2 475.5 41.3 11,518 7.2

2.0 517.7 41.7 12,426 7.3

0.0 552.8 42.0 13,152 7.8

20.3

14.9

26.4

22.8

25.6

28.0

35.0

19.75

10.00

11.25

17.19

15.44

21.00

25.00

3.45 12.6 2.1 3.0 46.4

3.80 16.9 3.6 1.3 48.0

3.98 11.6 0.8 1.9 52.2

4.30 10.0 -0.4 2.2 46.4

4.92 12.7 0.1 2.6 43.3

6.00 11.0 -0.2 2.4 39.3

7.80 8.0 -1.1 2.0 32.3

1.4 44.9

-0.6 48.2

0.2 44.6

-1.7 40.1

-2.6 41.5

-1.9 38.9

-1.9 37.3

Source: Central Bank, IMF, INDEC, Haver and Itaú.

Page 22

LatAm Macro Monthly – August 2013

Commodities

Favorable Weather Reduces Grain Prices • We have made downward revisions to our 2013 year-end forecasts for corn (to USD 5.5/bu from USD 6.0/bu), soybeans (to USD 12.5/bu from USD 13.0/bu) and wheat (to USD 6.8/bu from USD 7.3/bu), due to favorable weather in the United States. • Improvements in refining and distribution capacity of crude oil in the U.S. are consistent with a smaller WTI discount to Brent of around USD 5.0/bbl. • We have implemented a new methodology for the ICI. The revised index points to sharper drops in metal prices in 2013 (-9.7%) and 2014 (-7.0%). Lower agricultural prices were offset by a rebound in metal and energy prices in July. The Itaú 1 Commodity Index (ICI) dropped by an average of 0.6% from the previous month, as a sharp decline in agricultural prices was offset by a rebound in metal and energy prices. Commodities were affected by two pieces of news from the United States. First, favorable weather has reinforced the likelihood of strong corn and soybean crops. Second, improvements in refining and distribution capacity have been narrowing the WTI discount to Brent crude. Downward revisions in year-end grain price forecasts. The ICI Agricultural sub-index fell by Itaú Commodities Index * (2010=100) 10.4% in July. The slide can partly be explained by 140 *Monthly average the rollover of futures contracts for corn and prices according to the new methodology soybeans, but favorable weather also played a role. 130 Hence, we are cutting our year-end forecasts for corn (to USD 5.5 per bushel from USD 6.0 per bushel), 120 soybeans (to USD 12.5 per bushel from USD 13.0 per bushel) and wheat (to USD 6.8 per bushel from USD Previous 110 7.3). We now expect the Agricultural ICI to decline by 15.6% yoy (our previous call was -10.9%). Our baseCurrent case scenario incorporates a possible downward 100 Jan-11 Jan-12 Jan-13 Jan-14 revision in estimates for the harvested corn and Source: Itaú soybean areas in the coming months by the U.S. Department of Agriculture (USDA). If this revision does not materialize, prices may fall even further. Downward Revision Driven By Favorable Weather Conditions

Metal prices erase part of the decline seen in 2Q13. The ICI Metals sub-index climbed by 5.2% in July, led by iron ore. The price recovery was partly motivated by signs that the Chinese government may be willing to defend its 7.5% target for GDP growth in 2013. Among the incentive measures the government could implement, we would single out higher investments in railways and the smart grid, which would boost demand for iron ore, copper and aluminum. We maintain our call for a decline in metal prices. Despite the price hikes in July, we still believe that the market fundamentals are consistent with lower prices. Our forecasts for 2013 and 2014 remain unchanged. Our forecasts for the ICI Metals sub-index stand at -9.7% yoy and -7.0% yoy, respectively. A debate over potential reforms to the commodity markets in the U.S. (regarding the participation of financial institutions in the physical storage of commodities) may cause volatility in coming months, particularly for metals. High oil prices are consistent with fundamentals. The ICI Energy sub-index rose by 4.1% in July and is now in level with 1Q13. High prices are consistent with market fundamentals, particularly in the case of crude oil. Refiners have been able to pass through higher crude prices to end-products, and production increases by non-OPEC nations are being offset by lower OPEC output, partly due to 1

Series for the ICI and its sub-indexes were revised according to a new methodology, detailed in a specific section of this report.

Page 23

LatAm Macro Monthly – August 2013

conflicts in Iraq and Nigeria. Adjustments in the U.S. market (which involve a relocation of refining capacity to the central U.S., increased pipeline capacity and lower imports from Canada) are driving down the WTI discount to Brent in 2013, and we now expect the discount to be about USD 5/bbl by year-end. We are thus raising our year-end forecast for WTI crude to USD 105/bbl from USD 100/bbl, while maintaining our forecast for Brent at USD 110/bbl. Following this revision, our 2013 forecast for the ICI Energy sub-index rose to 6.6% yoy for 2013 (up from our previous call of 5.7%).

ICI: New Methodology Improves Consistency With Global Commodity Moves We have revised the series for the ICI and its sub-indexes to make them more consistent with the global macro scenario. International prices for 16 commodities (in USD, first maturity in the futures markets) are weighted according to each one’s global production value. The commodities are divided into three groups:  Agriculture: wheat, corn, soybeans, sugar, cotton, coffee and cocoa  Metals: iron ore, copper, aluminum, nickel, zinc, lead and tin  Energy: crude oil and natural gas New ICI: Methodology More Consistent With Global Commodity Moves

150 140 130 120 110

Itaú Commodity Index (2010=100)

Our biggest changes were increased weightings for iron ore and copper, which lifted the correlation between the index and GDP growth in emerging countries (especially China) and reduced the impact of metals of lower relative importance (in terms of global production value), such as zinc. The inclusion of iron ore is an advantage over other commodity price indexes.

According to the new methodology, the decline we forecast for metal prices in 2013 and 2014 is New ICI 90 Old ICI even steeper. Using the previous methodology, our metal pricing estimates were -4.4% yoy for 2013 and 80 Jan-10 Jan-11 Jan-12 Jan-13 -2.0%yoy for 2014. In the new index, the same price Source: Itaú data leads to pricing estimates of -9.7% in 2013 and 7.0% in 2014. The difference is explained by the heavier weightings for iron ore and copper. 100

Starting in the next report, we will release a new index with weightings meant to incorporate the effects of commodity-price shocks on Brazilian inflation (IPCA). In this index, which will be called ICI-Inflation, international commodity prices (in USD, first maturity in the futures markets) will be weighted according to their significance for the IPCA. Itaú Commodity Index Comparison 2013F New ICI Old ICI yoy - % -4.9 -5.6 Itaú Commodity Index (ICI) avg growth - % -3.7 -5.0 yoy - % -15.6 -9.6 Agricultural avg growth - % -9.9 -8.1 yoy - % 6.6 3.7 Energy avg growth - % 0.9 0.4 -9.7 -4.4 yoy - % Metals avg growth - % -3.3 -1.5

Page 24

2014F New ICI Old ICI -1.5 -0.1 -1.9 -1.0 1.6 1.0 -4.4 -3.6 -0.8 -1.3 3.7 2.8 -7.0 -2.0 -8.9 2.2

LatAm Macro Monthly – August 2013

Sugar and Ethanol: Weather Helps, but Exchange Rate Hinders Adjustments in Brazilian Production Following two years of surpluses in the global balance for sugar, the sector should find a new equilibrium over the course of 2H13. Sugar price declines in recent years have created incentives for a new equilibrium in the sector. International sugar prices have fallen by more than 50% since January 2011. Lower prices create incentives to restore equilibrium in the sector. On the demand side, cheaper prices boost consumption. On the supply side, lower prices squeeze profit margins, causing farmers to opt for other crops and to invest less in the remaining sugarcane plantations.

Sugar: End of Surpluses by 2H13 50

7 Million tons

Production Consumption Surplus/Deficit (RHS)

5

45

3 1

40

-1

-3 35 Mar-08

Sep-09

Mar-11 Source: Itaú

Sep-12

-5 Mar-14

A decline in sugar production in Brazil is needed to avoid another surplus in the global balance. Our base-case scenario incorporates a decline in global production excluding Brazil amounting to 5 million metric tons, and an increase in consumption of 3 million tons. These adjustments are not enough to prevent new surpluses from being accumulated between April 2013 and March 2014. Hence, equilibrium between supply and demand depends on weather surprises affecting output in a producing region or on a large adjustment in Brazilian production. It is possible that current prices are already lower than equilibrium levels, but uncertainties and a sluggish response from production may create volatility in the medium term.

Weather conditions have delayed harvesting and lowered total recoverable sugar in the Center-South region of Brazil. Following a summer of favorable conditions for sugarcane plants, rainfall in April, May and June delayed the harvest. Furthermore, a recent cold spell possibly affected a large part of the crop, which may contribute to a decline in total recoverable sugar (ATR, in its Portuguese acronym). Taking these factors into account, we forecast a harvest of 580 million tons in the Center-South (our previous call was 590 million) and an ATR of 135 kg per ton of sugarcane (our previous call was 137 kg/ton). Hence, the change in the production mix in Brazil needed to prompt a decline in sugar output is not as large. Depreciation in the Brazilian currency affects relative prices between sugar and ethanol, but sugar production should be lower than in the previous year. In addition to depending on harvested sugarcane, sugar production in Brazil depends on the allocation between ethanol and sugar. The allocation, in turn, depends on relative prices. Throughout 2012, relative prices favored sugar output. But in the early months of 2013, the drop in international sugar prices led relative prices to favor the production of hydrous ethanol, pushing a greater part of the harvested sugarcane into ethanol production. However, the recent depreciation in the Brazilian real drove sugar prices relatively higher (in USD) than hydrous ethanol prices (which do not react to exchange-rate depreciation when there is no pass-through to domestic gasoline prices). Consequently, the mix of sugarcane utilization for the remainder of the crop may once again favor sugar production at the margin. Still, our forecast is for utilization of 44.3% of the harvested sugarcane for sugar production in

Page 25

LatAm Macro Monthly – August 2013

the 2013/14 crop, vs. 49.8% in the 2012/13 crop. Sugar production in the Center-South is estimated at 33.1 million tons, or 1 million less than in the previous crop. We maintain our forecast for a sugar price of 17.65 cents/lb. at year-end. The downward trend in international sugar prices continued until mid-July, when a cold snap in Brazil led to some price recovery. Even with the local currency at weaker levels, the loss of sugarcane quality should cause sugar production in Brazil to be lower than last year, driving the global balance closer to equilibrium over the next three quarters.

Forecasts: Commodities Commodities CRB Index - yoy - % CRB Index - avg growth - % Itaú Commodity Index (ICI)** - yoy - % Itaú Commodity Index (ICI) - avg growth - % Metals - avg growth - % Energy - avg growth - % Agricultural - avg growth - %

2008

2009

2010

2011

2012

2013F

2014F

-25.7 6.2 -32.9 14.6 4.0 33.2 30.8

35.4 -14.6 44.8 -20.8 -18.9 -39.2 -20.3

21.9 25.1 28.4 21.8 78.5 22.0 15.7

-5.2 19.5 -6.5 24.9 13.7 25.6 35.1

0.8 -9.5 3.5 -7.9 -19.4 -2.4 -5.1

-5.6 -3.2 -4.9 -3.7 -3.3 0.9 -9.9

-0.5 -3.2 -1.5 -1.9 -8.9 3.7 -4.4

Source: Bloomberg and Itaú. ** The Itaú Commodity Index is a proprietary index composed of those commodity prices, measured in U.S. dollars and traded in international exchanges that are relevant to Brazilian consumer inflation. Its sub-indexes are Metals, Energy and Agricultural.

Relevant information 1.

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2.

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4.

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Page 26

LatAm Macro Monthly – August 2013

persons should act upon it; (vi) Brazil: Itaú Corretora de Valores S.A., a subsidiary of Itaú Unibanco S.A authorized by the Central Bank of Brazil and approved by the Securities and Exchange Commission of Brazil, is distributing this report. If necessary, contact the Client Service Center: 4004-3131* (capital and metropolitan areas) or 0800-722-3131 (other locations) during business hours, from 9 a.m. to 8 p.m., Brasilia time. If you wish to re-evaluate the suggested solution, after utilizing such channels, please call Itaú’s Corporate Complaints Office: 0800-5700011 (on business days from 9 a.m. to 6 p.m., Brasilia time) or write to Caixa Postal 67.600, São Paulo-SP, CEP 03162-971. * Cost of a local call.

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